Lease & Finance Accountants Conference. September The Westin Charlotte Charlotte, NC

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1 Lease & Finance Accountants Conference September The Westin Charlotte Charlotte, NC H A N D O U T S

2 Credit losses (ASU )

3 Agenda Scope Current Expected Credit Losses (CECL) Model Effective Date and Transition Transition Resource Group SEC Staff Announcement

4 Scope

5 Scope In scope Loans Loan commitments Financial guarantees Trade receivables Lease receivables recognized by a lessor Receivables that result from revenue transactions Debt securities classified as held-to-maturity Debt securities classified as available-for-sale CECL Out of scope Equity instruments Financial instruments measured at FV through NI Loans made to participants by defined contribution employee benefit plans

6 Scope operating lease Fact Pattern: Lessor LR leases a piece of manufacturing equipment to Lessee LE for 5 years. For ease, there are no non-lease components of the contract. The lease commences on January 1, Year 1 and LR is a calendar year-end reporting entity. Payments are: Fixed and in advance each year - $1,000 in Y1; $1,100 in Y2, $1,200 in Y3; $1,300 in Y4, $1,400 in Y5 Additionally, LE is required to make variable payments, in arrears (with net 45 day payment terms), equal to $1 per unit produced with the equipment. Assume units produced in Years 1-5 are, respectively: 1,000; 1,050; 1,075; 1,150; 1,250. LR will recognize operating lease revenue of $1,200 per year ($6,000 fixed payments / 5 years) and variable lease revenue of $1,000 (Y1), $1,050 (Y2), $1,075 (Y3), $1,150 (Y4), $1,250 (Y5). December 31, Year Accrued rent receivable (straight-line amount) 1 $200 $1,000 2 $300 $1,050 3 $300 $1,075 4 $200 $1,150 5 $0 $1,250 Variable lease payment receivable

7 Scope operating lease Are operating lease receivables and straight-line lease receivables within the scope of CECL? View A - Within the scope of CECL Subsequent collectibility assessment guidance in Topic 842 only addresses where collectibility changes. CECL would apply even when collectibility is probable. Receivables that result from revenue transactions and operating lease receivables both include a collectibility threshold. Receivables from revenue, and contract assets (equivalent to straight-line lease receivables) are in the scope of CECL. View B - Not within the scope of CECL Not explicitly listed as an item within the scope of CECL Lease guidance applies at the commencement date and addresses accounting for subsequent changes in collectibility. No clear guidance in Topic 842 that operating leases receivables should be assessed for impairment under CECL Straight-line lease receivables (or portions thereof) may not meet definition of a financial asset.

8 Current Expected Credit Losses (CECL) Model

9 Main areas of change No probability threshold Expected lifetime loss estimate Estimate future economic conditions

10 Measurement of expected credit losses Estimate losses over the entire contractual life Estimate future economic conditions Recognize losses, even when likelihood is remote Pool assets with similar risk characteristics

11 Determining a loss estimate Lifetime historical loss estimate Adjustment for differences in asset attributes Adjustment for differences in economic conditions Current expected credit losses (CECL) estimate Estimate economic conditions over a period that can be reasonably forecasted and supported. After that period, revert to historical loss experience.

12 Reversion Revert to historical experience that was used as a starting point in the absence of reasonable and supportable forecasts Inappropriate to assign a loss of zero to future periods merely because of concerns over the precision of the estimate Stakeholders requested flexibility Revert immediately, on a straight line basis, or using another rational or systematic basis

13 Loss curve

14 Potential for diversity Judgment needed Look-back period to measure historical loss experience What period should be used? Methodology to use Reasonable and supportable forecast DCF Loss rate Vintage Other What is reasonable & supportable? Which one? How long? Revert to historical losses Immediate, straight line or other?

15 Effective dates and transition SEC filers Public business entities: Fiscal years beginning after December 15, 2019 Non-SEC filers Public business entities: Fiscal years beginning after December 15, 2020 (including interim periods within those fiscal years) For all other entities: Fiscal years beginning after December 15, 2020 (and interim periods thereafter) Early adoption Fiscal years beginning after December 15, 2018 Transition Cumulative effect adjustment to the statement of financial position as of the beginning of the first reporting period

16 Lessor net investment in a lease Lease receivable Right to receive future lease payments + guaranteed residual value Credit Risk Unguaranteed residual asset Unguaranteed portion of estimated residual value Noncredit Risk Total Net Investment in the Lease 1 1 If lease is a direct financing lease, any selling profit is deferred and the deferred selling profit reduces the net investment in the lease. Lease receivable and unguaranteed residual asset discounted using rate implicit in the lease The lessor s entire net investment in the lease is assessed for impairment using CECL

17 Example net investment in a lease Fact Pattern: Lessor LR leases bulldozer model XYZ and recognizes net investments in leases Leases have a remaining duration of five years LR decides to use a loss rate to measure impairment LR pools leases with similar risk characteristics LR identifies the historical period to use to develop historical loss rates LR develops separate loss rates for credit (lease receivable) and noncredit risk (unguaranteed residual value) Reasonable and supportable forecasts over the next five years: GDP will decrease Bulldozer model XYZ values will depreciate quicker than historical information LR can reasonably forecast for the remaining duration of the leases

18 Example net investment in a lease Risk Unadjusted historical rates Adjustment for current conditions and reasonable and supportable forecasts GDP Bulldozer model XYZ values Expected rates Original balance Expected losses Credit risk Probability of default 5% 1% 6% Loss given default 22% 2% 24% Total loss rate 1.10% 1.44% $12,000,000 $172,800 Noncredit risk Original residual balance as % of original net investment in the lease balance 7% Original residual balance $840,000 Probability no default will occur 95% -1% 94% Loss if no default occurs 11% 0.5% 11.5% Total loss rate 10.45% 10.81% $840,000 $90,804 Pool A - Total expected credit losses $263,604

19 Transition Resource Group

20 Transition resource group (TRG) Discusses implementation issues Issues can be FASB.org Consists of preparers, auditors, and users Observers Board, staff, regulators FASB will decide whether they will issue additional IG

21 SEC Staff announcement

22 SEC Staff announcement on disclosures Additional qualitative disclosures if effect is not known or reasonably estimable. Disclose progress in implementing the new standard. Disclose significant implementation matters to be addressed.

23 SEC Staff announcement on disclosures Whether an initial estimate of the impact of CECL adoption has been developed. Whether key decisions have been made regarding CECL adoption that would be of interest to investors. Incorporating into their implementation plan the development of more specific information for future disclosures.

24 Presenter s contact details Scott Muir Phone: smuir@kpmg.com Danielle Imperiale Phone: dimperiale@kpmg.com